Dong delights investors with hybrid debut

Bringing a debut issue is never an easy task in the corporate bond market, and for a company to issue a new and untested structure on its first appearance could be considered sheer folly. But as
Alistair Dawber
reports, Danish Oil and Natural Gas overcame any doubts and issued a hybrid deal with flying colours.

Before 2005, debt capital markets bankers and investors had had little to do with Dansk Olie og Naturgas, the state owned company also known as Danish Oil and Natural Gas, or Dong.

But when the company launched a Eu1.7bn transaction in June, Eu1.1bn of which was hybrid capital, it did not take them long to understand the company's credit and accept it as a newcomer to the European corporate bond market.

Dong not only managed to pull off a great transaction but also cemented the place of corporate subordinated debt in Europe — enough to win investment bankers' votes as new borrower of the year in EuroWeek's Investment Banks' Poll 2005.

Last June the word on everyone's lips in the corporate bond market was hybrid. Moody's had opened the gates in February by issuing a paper which set out its views on the relative equity and debt content of various kinds of subordinated bond.

That gave companies and investment bankers a blueprint for designing worthwhile structures, and before the ink was dry CFOs and coverage bankers were weighing up the opportunities.

It took until the summer before deals started to appear, but Dong was among the first, issuing its bond shortly after German sugar producer Südzucker and Vattenfall, the Swedish power company.

Dong had not issued bonds before but the change in Moody's methodology made a hybrid issue attractive, after it had agreed in 2004 to merge with Danish electricity company Elsam and buy gas assets in Norway and part of Germany's Energie und Wasser Lübeck.

"We opted for a hybrid structure for a couple of reasons," said Morten Hultberg Buchgreitz, senior vice president in the group treasury at Dong in Hørsholm, Denmark. "Compared to equity it offered very attractive funding, while the equity element allowed us to strengthen our capital structure in light of the acquisitions we made last year. For us it made a lot of sense."

Lead managers BNP Paribas, Deutsche Bank, Morgan Stanley and Nordea agreed that the hybrid route was the right course for Dong.

"Dong made a couple of big acquisitions last year," says Frederic Zorzi, co-head of European syndicate at BNP Paribas in London, "but it did not want to put any pressure on its ratings and wanted to strengthen its balance sheet ahead of the agreed acquisitions. Because it is 100% state owned and the government did not want to dilute any of its ownership, the hybrid was the perfect option for Dong."

A sizzler

The transaction came in two tranches, a Eu500m seven year senior issue and a Eu1.1bn subordinated 1,000 year non-call 10 tranche, which won 50% equity treatment from Moody's and Standard & Poor's.

Südzucker and Vattenfall's issues had won 75% equity credit from Moody's by incorporating triggers that would oblige the issuers to defer coupon payments.

Dong's deal has no such mandatory deferral triggers, making it more attractive to investors. The issuer has the option to defer coupon payments, but only if it also defers dividends.

"Demand for the hybrid transaction was exceptionally strong," says Richard Tynan, head of corporate debt syndicate at Morgan Stanley in London, which was structural adviser on the deal.

"On final allocations it was almost three times oversubscribed, and at the initial size we had a book more than six times bigger than the anticipated deal — an incredible success, given that at the time this was such a new product. It also marked the biggest ever corporate hybrid Eurobond and the biggest bond ever issued by a Danish company."

Investors did not seem to object to the fact that the deal was a debut. "This is an impressive debut deal and it was wise for the issuer to bring a senior tranche as well as the hybrid," said one syndicate manager in London at the time of the launch. "It aided the price discovery process and gave investors not interested in the subordinated debt exposure to a new name in the market."

Hybrid deals often take longer to put together than straight bonds. Dong had been considering an issue for some time, but it was only when Moody's published its position piece that the ideas took shape.

"One of the most satisfying aspects of the transaction was the way in which the management of the company persuaded investors that the deal was sound," says Zorzi. "The job was made especially difficult because of Dong's status as a debut issuer, but they came through with flying colours."

With an initial public offering planned in the next few years, Dong may be absent from the debt markets for some time. But, by launching one of the first and most successful hybrid bonds of 2005 on its debut, Dong has left an indelible mark.